ICELAND:

In 2008 They Took an L, but

Now They Bounce Back

Money and Banking

Dr.Kalpana Khanal
April 26, 2017

By: Brien Thompson, Chris Deming, Paul Sickinger & Dailaine Dos Reis
Table of Content

Thesis 3
Abstract 3
History of Iceland 3
Iceland 2.0 4
Outcome of Accelerated Growth 6
Devaluation of the Krona 9
Prosecution of those Involved 11
Conclusion 14
Work Cited Page 16

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Thesis
Iceland's economic rebound from the 2008 Global Financial Crisis can be attributed to
the allowances of the collapse of the major banks, the devaluation of the krona, and the
prosecution of financial and government leaders who orchestrated the Global Finacial
Crisis. By analyzing these key components of Iceland's financial crisis, one will be able to
understand the reason behind their miraculously

Abstract
Regardless of the economy, all economies face the booms and busts of the business
cycle. Iceland is no exception. However, they do serve as a pure example of the
financial fragility of the developed world. By understanding their history, one can better
understand the impact financialization had in their economy. They serve a standing
example of the outcomes of financial casinos and their role in a destructive manner.
Icelands decision to allow the banks to collapse, devaluation of the krona, and prosecute
leaders who contribute to the Global Finacial Crisis show that a country can thrive
without the balling out of too big to fail institutions or individual's of power. By limiting
the burden of the banking collapse and using monetary and fiscal policy, Iceland has
now a thriving and more stable economy.

History of Iceland
Iceland remained in a quasi-feudal colony of Denmark to the 1850 and gained
independence from Copenhagen in gradually starting in 1904. Due to over six hundred
years under foreign rule, Iceland was considered the most full of all the Nordic
countries. Fishing dominates Iceland's early independent economy, generating foreign-
currency earning that helped the developing of a thriving import base commercial
sector. Capitalism was predominantly dominated by fourteen families, known as the
Octopus; for over fifty years, most of the Iceland was govern by one of the between the
families and the private sector. Though political parties became prominent in the in war
periods, many public officials remained to be chosen by those in the Octopus family
until today. The limited numbers of strong economic activity caused the focus of Iceland
to focus on tangible commodities, like having a thriving fishing sector, creating limited
growth. At this time, Iceland had a small population of about 300,000 people to support

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with an above average level of education. This led to a significant degree of growth over
those twenty years.( Robert and Sigurgeirsdottir)

Following the Second World War, the Icelandic economy underwent strong growth due
to their high literate population and benefits awarded due to the Marshall Plan. By the
1980s Iceland was able to attain a level and distribution of income paralleled to other
Nordic states. However, the regulation and maintenance were dominated by local
oligopoly dominated both politically and economically. This can be seen in by the major
banks being Landsbanki, which was sponsored by the Independence party and
Bunadarbanki, as the agricultural bank. Those who did not pertain to family or political
alignment would need to go to party functions in hopes of looking for a loan.( Robert
and Sigurgeirsdottir)

The promotion of free market ideas originated by students at the University of Iceland
who promoted their view on in a local journal. Post-Cold War, the ratifying view of free
market gained momentum. One of the group members, David Oddsson, quickly rose to
power and was elected to the prime minister for the next fourteen years. Oddsson then
installed himself as governor of the central bank, due to his experience overseeing
Iceland's economic growth.(Matsangou)

Iceland 2.0
Iceland was still regarded as one of the poorest Western European states. To combat
this stigma, Iceland focused on looking inward to expand its economy. Between 1960
and 1980, Iceland was driven by a combination of Marshall Plan aid and an abundant
export commodity with the unusual property of a high elasticity of demand. (15). With
David Oddsson being elected as prime minister, his priority was to stimulate Icelands
growth even further was to focus on privatization and deregulation. Iceland evolved it
economically by liberalizing many sectors on the beginning of 1994, due to them gaining
access to the European Economic Area. The EEA was a group of European nations that
provide free-trade within their territories. The financial sector remained small in
comparison to their European states. In hopes to grow, the privatization of financial
entities began in 1998.( Robert and Sigurgeirsdottir)

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With the implementation of deregulatory policies, a new wave of elites rose into
influence. Mergers of banks, both big and small, caused financial developments such as
private equity companies as me to buy larger shares of the three major banks. New
families and banks had become wealthy from retailing, international business, and
owning companies with major fishing quotas used their power to gain power in the
emerging financial market. Within the years of 1998-2002, the government privatized
the two largest state-owned banks and fostered the creation of a third big bank from the
merger with smaller ones. (Robert and Sigurgeirsdottir). These would become Icelands
big three: Landsbanki, Glitnir, and Kaupthing. Many shareholders of these banks had
little experience in the banking industry, mainly dealing with international finance. The
set up of private equity funds outside of the bank would be used by the big bank to
receive loans to purchase assets. Then they would use these assets as collateral to
acquisitions even more assets. They would continue to do this, making the balance
sheets of both their private equity fund and the major banks balance sheets look
stronger.

The significance and power of the financial sector were like nothing Iceland had seen
before. Due to this, there was no real monitoring of the financial sector. One major
Icelandic bank would loan another Icelandic bank one billion Krona. Then the receiving
bank would reciprocate the same loan to the original lending bank. Despite these loans
going on their books, there would be no exchange of actual money. These banks would
then go to a foreign bank and use their loan to
the other bank as collateral to receive a loan
from the foreign bank. Icelandic banks were
able to grow their assets at 50% a year and
more( Robert and Sigurgeirsdottir). Of course,
they would funnel some of the growing profits
into retained earnings so they could reward
themselves and their shareholders healthily.
(Scrutton,1)

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These, allegedly illegal, tactics made the Icelandic banks interdependent on one
another. Meaning that if one of the three major banks crashed, the other two would fall
with them. It also surged these banks into the ranks of the worlds biggest 300 banks
in 2006. (Robert and Sigurgeirsdottir) With this newly spawned power and wealth,
major bank executives and shareholders began spreading their influence throughout the
country. They made generous donations to politicians in their respective parties, they
purchased control of media outlets, and all the while, the governing individuals praised
them for their contributions to the country. In hopes to continue their prosperous
appearance banks found a new way to increase assets by following the model of
investment banks on Wall Street in the United States: credit default swaps on Icelandic
bank bonds. Banks also involved in investment schemes, like Icesave to help mask their
liquidity issues.

An epidemic of greed, wealth, and ignorance would ultimately lead up to Icelands

economic demise. Icelands big three banks: Landsbanki, Glitnir, and Kaupthing would
continue to grow exponentially.

Outcome of Accelerated Growth

Originally, the Icelandic banks serve mainly locally; the three largest banks served just
over one year's gross domestic product. By 2007, the three largest banks assets totaled
to ninefold the gross domestic product. The rapid growth of the financial sector was a
pivotal reason as to the why the crash was inevitable. As a means to stimulate foreign
and domestic investment, Iceland government implemented new strategies to increase
economic growth. However, due to the markets unstable state, the rapid expansion was
short-lived. As shown in the graph, the aggregate size of the banks increased
dramatically in a small window of time. The risk associated with such rapid growth of
the sector is risk associated with the distinction of internal and external growth. The
distinguishing factor of growth is: internal growth occurs due to existing activities, such
as increasing loan which also increases their loan portfolio; external growth is due to the
acquisition of assets or other entities, in that supports the original portfolio. In other
words, the bank must have both internal and external growth to thrive economically. If a
bank only has internal growth, the bank and the portfolio becomes a risky investment

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and could be highly volatile. Considering the size increasing the size of the banks and
their level of participation in the overall economy, their impact could be fatal to the
overall state of the economy.

Concentration of Risk
Understanding the difference between internal and external growth and it is
significance, it is also important to look carefully as to whom the banks are lending to
accurately assess their growth and stability. The graph show provides a visual
representation that shows the parent companies lending endeavors. As shown in the
figure, there was an increase in lending to the
household sector. The expansion can de explain
(Scrutton,5) the increase in competition due to Housing
Financing Fund, enacted to stimulate the housing
market. However, the most significant increase of
lending was lending to foreign parties. This was
attributed to the international crisis. In the same
time, there was also a clear increase in lending to
holding companies. Due to the liquidity crisis,
lending by the parent companies as a means to
reducing the lending. This shows that the balance
sheets and lending portfolio of these institutions grew beyond their control and
knowledge. The bankers resorted to lending in an increasing high-risk asset due to lack
of proper supervision and management. However, the growing number of shares of
these toxic investment would cause catastrophic consequence once to the economy as a
whole. Due to parent banks being dependent on their holding companies and other
banks, one bank's collapse could resort in complete the potential demise of the sector as
a whole.

Risk diversification is key to the vitality of banks. With a widespread risk of assets and
portfolios to prevent the extensive damages to one or multiple customers. If the risk is
not adequately spread, the bank becomes dependent on the performance the one asset
or portfolio. In means to prevent the concentration of risk, Iceland adopted rules on

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large exposure similar to Norway and Denmark that aimed to prevent the domino effect
with potential financial difficulties. It stated that banks were not permitted to incur
exposure about one customer, or group of customers, that are related in a certain way,
more than 25% of their equity base at any time. The law was designated to prevent the
concentration of risk of a bank. However, the implementation was scarcely considered
until the collapse of the banks.

A clear example in the banks planted regard to regulation to limit risk concentration can
be shown when examining Landsbanki, one of Iceland's top three banks. The Foreign
Exchange Market (FEM) contacted Landsbanki stating that there was the belief of over
exposure in late March 2007. The latter called to the attention that Mr.Bjogolfur may
have conflicts of interest due to the relation extent of the relation to Actavis hf. At that
moment, Mr.Bjogolfur owned a 38.84 share in Actavis Group fh. At that time, was the
chairman of financial firm Straumur-Burars and Landsbanki, causing the shares to be
defined in conjunction with Mr.Bjogolfur. The letter further stated that the exposure to
Mr.Bjogolfur to amount to ISK 51.3 billion or 49.7% of the banks CAD equity at that
time However the Landsbanki rejected their claims and further alleges were ignored.

The concentration of risk is only one of many reasons that contributed to the fall of
Iceland's major banks. In hopes to maintain their strong financial appearances, banks
also began to invest in foreign investment and derivatives markets. The use of
implementations of Icesave and Collateral Debt Obligations further exposed their risk
within major banks and the international market. The banks continuously disregarded
regulation as well as manipulated information causing many to feel that the banks
should not be bailed out. The banks extended the liability of the government causing the
burden to land on the Icelandic citizens while the banks remained unreprimanded.
Island choose to go against the norm and allow the banks to collapse. The magnitude of
the deficit caused by the banking industry would cost the Icelandic people extensively; if
the government did choose to save the banks, it would be almost impossible for Iceland
to become stable economically. The people of Iceland were also extremely vocal at this
time. With all of these factors, the Icelandic government chooses to not bail the banks to

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minimized the debt burden to its people and to allow themselves to one day be stable
economically again.

Devaluation of the Krona

Due to Iceland having a sovereign currency, compared to similar countries who suffered
from the Global Financial Crisis and are attached to the Euro, they were allowed them to
make necessary monetary policy that was able to better equip the country after the crash
than the countries who participates in the Euro. Once the Global Financial Crisis of
2008 hit Europe, many countries in Europe were dramatically affected. Whether it was
Iceland, Ireland, Germany, or Greece, the Eurozone was plunged into a recession just as,
if not more, devastating as the impact it had on the United States. Currency purchasing
power across the Eurozone plummeted, whether it was the English Pound, the Euro, or
the Icelandic Krona. Icelands three biggest financial institutions had borrowed from
foreign investors more than three times the countrys GDP, and when the bubble burst,
it seemed that Icelands economy was undoubtedly going to collapse. Surprisingly,
however, Icelands economy was able to recover from the collapse much better than
many other Eurozone economies. Because of this, economists have been studying how
Iceland was able to rebound so efficiently and to do this; many economists look to see
what Iceland did differently than other countries with similar sized economies. The
closest comparison experts have deemed a comparison between Iceland and
Ireland. Both countries strikingly similar economies, but Iceland recovered much
quicker than Ireland. One of the biggest conclusions as to why this is possible is because
Iceland uses its sovereign currency, the Krona, where Ireland is part of the European
Union which uses the Euro. The reason why
this is so significant is that Ireland could not
manipulate its currency because the
European Union has control of the currency,
not the individual states. Iceland, on the
other hand, was able to manipulate its
currency using monetary policy after the
crash which situated the country to recover
(O'Brien,1)
quicker. The following figure shows a

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comparison if Icelands and Irelands GDP before and after the 2008 Global Financial
Crisis.

Once the government discovered the amount of debt that the top three banks had
amassed, they chose to let the banks fail instead of bailing them out. Icelands
government declared that they would only be recovering the Icelandic citizens money
lost by the banks, but would not be held responsible for any foreign debts the banks
owed. In turn, sent the value of the Krona plummeting. To stop this, the International
Money Fund bailed out Iceland enough to prevent the Krona from losing total
purchasing power. This loan only stopped the Krona from falling, even more; it did not
help restore it to a higher level of purchasing power. The limitation of power posed a
significant obstacle to Iceland because the economy needed to cut costs because of the
currency crash. If Iceland had not implemented monetary policy to devalue their
currency, companies would have cut wages for its employees to make these cost
reductions. This, in turn, would have made citizens nervous, which would have
increased the marginal propensity to save. If the marginal propensity to save is
increasing, that means citizens are consuming less. An economy needs to increase its
GDP, and if consumption is falling to recover from a recession, a. Luckily, Iceland
prevented this from happening. Iceland decided to devalue the Krona by 60%. This
enabled companies to cut costs while still paying the same nominal wages to its
citizens. In turn, residents felt they were still being paid the same amount and were
more willing to continue their spending level before the crash. Not only did the
devaluation allow for this to happen, but it also prevented a decrease in competition. If
companies had to cut costs by cutting wages, this would have put the worker at a
disadvantage. This is because there would have been a massive increase in demand for
more working hours, which would have allowed companies to have more control over
the hiring process. Workers would have been subject to lower than needed wages due to
the high supply of labor. By devaluing the Krona, competition would stay level, allowing
workers to maintain reasonable salaries. This too allowed for the spending level to stay
the same.

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One of the consequences of the devaluation of the Krona was that it caused a relative
mortgage crisis in Iceland. Mortgages and other loans had to be taken out before the
Global Financial Crisis were valued using the pre-devalued Krona. Therefore, once the
Krona was devalued, mortgage payments soared. This is because the value of the Krona
that borrows are currently paying with is 60% less than what the loan is
appraised. Burrows are making the maximum amount of payments, but they are not
able to even cover the cost of interest. Instead of paying off their mortgage, they are
making monthly payments but seeing their debt balance rise. This is resulting in a rise
of home evictions in Iceland, and the government is still deliberating on how to fix this
problem.

Iceland was able to devalue their currency, which allowed for the nominal wage to stay
the same, prevented an increase in the marginal propensity to save, and halt a decrease
in competition. Countries like Ireland and Greece, on the other hand, were stuck using
the Euro, which allowed them no
monetary flexibility. They were
not able to compensate for the
crash by manipulating their
currency, which resulted in
worsening the situation. This has
resulted in poor living conditions
and a reduction in the flow of
capital to those countries, where
(O'Brien,1) Icelands GDP is 1% bigger than it
was before the crash.

Though these were clearly some drawback to the devaluation of the Krona, such as the
mortgages, the overall impact was positive. As shown in the graph, the devaluation of
the Krona has made it more competitive in the global market. Due to the devaluation of
the Krona Iceland was better able to bounce back.

Prosecution of those Involved

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Poor evaluation and prosecution of Iceland's financial and government leaders is part of
the orchestration of the Global Financial Crisis. One particular individual named,
Bjrglfur Thor Bjrglfsson, chairmen of Landsbanki, caused the Icelandic people
several billions of dollars in debt due to poor government assessment leading up to the
crisis. One of the controversies was big bank owners, like Bjrglfur Thor Bjrglfsson,
being the largest borrower of their bank. In this case, Bjrglfsson would benefit from
being an owner of having easy access to loan facilities. Research shows that when bank
partners, are at the same time, borrowers, they suspiciously favor from deals. Another
large bank that failed during the Global Finacial Crisis was Kaupthing bank. Poor
corporate governance and substantial amounts of debts led to the downfall of
Kaupthing, but for a while, there were no bank executives to blame. Iceland's
prosecution process is exceedingly slow and has angered the people who lost
tremendous amounts of money during the Global Finacial Crisis. Iceland eventually
cracked down on some executives of Kaupthing bank, but it took a long time. Their
prosecution process is slow due to the argument that no individual is significant enough
to be prosecuted for such a large event. Bjrglfur is lucky that Icelandic courts have
seen it that way.

Bjrglfur Thor Bjrglfsson is one of the most well know Icelandic businessman and
entrepreneur in the 20th century. He was the former chairmen of financial firm
Straumur-Burars and Landsbanki. The failure of Landsbanki and Straumur was
detrimental to the people of Iceland, causing families to go bankrupt, lose their homes,
jobs, etc. Bjorgolfsson allowed Landsbanki and Straumur to lend out large amounts of
money to their members and it reached a point where they could not pay it back. He also
invested too much money in foreign markets without anticipating bank rates to go up.
Eventually, the banks grew at colossal rates, and they did not check themselves. Poor
corporate government regulation can be one to blame for this as well, but Bjorgolfssons
bank rates grew so high that not even their country could help them out. He looked
abroad for financial aid, but could not acquire nearly enough money to back up their
loans. Lending and borrowing money caused what many refer to as a bubble, and it
popped. Bjorgolfsson had nowhere to turn.

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Bjorgolfsson potentially could have served time in jail, but did not. One of the
arguments or controversies is Bjorgolfsson having easy access to loans in his banks
because he is an owner. When the GFC struck, his banks put more emphasis in
protecting and saving the owners rather than members and the thousands of
shareholders. Landsbanki and Straumer cared more about the needs of their biggest
shareholders, Bjorgolfsson being one, and made sure they maximized those
shareholders benefits. They were not a reliable bank where all interests of the
thousands of shareholders were taken into consideration. There was no sympathy or
responsibility towards creditors.

As mentioned before, another large bank that failed during the GFC was Kaupthing
bank due to poor corporate governance and poor evaluation of executives that were
illegally manipulating the market. Seven years after the GFC, former CEO, Hreidar Mar
Sigurdsson and former chairman, Sigurdur Einarsson, were convicted of market
manipulation. They were sentenced to five years on February 12th, 2015. After the crash,
these two executives chose to move and go live abroad. They could not escape for too
long. A special prosecutor convicted Hreidar Mar Sigurdsson for falsifying documents,
embezzlement, breach of trading laws as well as market manipulation. What made this
man a point of interest were his actions involved with Heikh Mohammed Bin Khalifa
Bin Hamad al-Thani', a close member of the Royal House of Thani. Einarsson
suspiciously sold Bin Hamad al-Thani' 5.1% of shares in Kaupthing just weeks before the
2008 global financial crash. The public was disappointed that it took so long for the
government to prosecute these two men. This shows how slow and inadequate Icelands
prosecution system is and proves the government did not have an eye on bank
executives leading to the crisis. In Europe, some banks have been fined, and few
executives have been tried. Many believe bankers got off likely. Today, there have been
regulations implemented to prevent something like this to happen again, but the people
of Iceland will never forget what they went through.

Though the prosses of criminal charges against bankers and others involved did take a long
time, Iceland was one of the first nations ever to protect those involved in the Global Finacial

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Crisis. As of today, thirty-five have been prosecuted, twenty-six of which were persecuted by
Icelanders. Iceland has been the most vocal nation to actively bing justice to its people through
the justice system. In 2008, the Icelandic citizens forced the resignations of the prime minister,
David Oddsson, and others in the government due to them being partly at blame for the Global
Finacial Crisis. In 2010 Iceland invited David Oddsson and failed over two hundred criminal
charges against bankers and former CEO's; others who were not criminally charged were forced
to live Iceland. Later that year, Iceland nationalized their banks and forgave debts exceeding
110% of home values in blue of the ongoing mortgage dilemma. Thought judicial proceeding are
at times prolonged, they provide justice to the people of Iceland as well as their future. (O'Brien,
89)

Conclusion
Iceland was the first country in over 30 years to request monetary aid from the
International Monetary Fund in 2008. Due to this, many expected their fates to be
similar to Ireland and Greece, where countries economic development has been
stagnant at best. However, due to them allowing the banks to fail, devaluing the Krona,
and prosecuting
those involve in the
Global Financial
Crisis, today it is a
success story.

As shown the
(Howden,1)
graphs, Iceland is
currently thriving post the Global Finacial Crisis. Unemployment which was once
around six percent is now constantly lowering and is gradually decreasing, reaching
around four percent in 2015. The Gross Domestic Product of Iceland is shown to be
stabilizing and through the devaluation of the Krona caused export revenue to increase
substantially. The government spending is shown to be lowering in a constant and
positive manner as well as the interstates lowering, causing an influx of investment to
the Icelandic Economy.

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The Global Financial Crisis impact on Iceland has brought to light alternative
perspectives for when dealing with too big to fail industry and their impact on the
economy. The significance of regulation and enforcement of policy is detrimental to any
sector; the importance of solvency to properly mediate a nation in need is crucial; as
well as the prosecution of those involved in the demise of an industry should be brought
to justice in order to instal hope to its people and the future of the nation.

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Matsangou, Elizabeth. Failing Banks, Winning Economy: the Truth about Icelands Recovery. World
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recovery. Accessed Feb. 2017.
Morgan, Derrick. Europe's Fiscal Crisis Revealed: An In-Depth Analysis of Spending, Austerity, and
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